The Psychology of Pyramid Schemes
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The Psychology of Pyramid Schemes MULTI-LEVEL MARKETING OR ILLEGAL PYRAMID SCHEME? What is the Difference? http://www.youtube.com/watch?v=DQLUyLHi9qc Pyramid Schemes As in Ponzi schemes, the money collected from newer victims of the fraud is paid to earlier victims to provide a veneer of legitimacy. In pyramid schemes, however, the victims themselves are induced to recruit further victims through the payment of recruitment commissions. More specifically, pyramid schemes—also referred to as franchise fraud or chain referral schemes—are marketing and investment frauds in which an individual is offered a distributorship or franchise to market a particular product. The real profit is earned, not by the sale of the product, but by the sale of new distributorships. Emphasis on selling franchises rather than the product eventually leads to a point where the supply of potential investors is exhausted and the pyramid collapses. At the heart of each pyramid scheme is typically a representation that new participants can recoup their original investments by inducing two or more prospects to make the same investment. Promoters fail to tell prospective participants that this is mathematically impossible for everyone to do, since some participants drop out, while others recoup their original investments and then drop out. 1 What is a Pyramid Scheme? Pyramid schemes are illegal scams in which large numbers of people at the bottom of the pyramid pay money to a few people at the top. Each new participant pays for the chance to advance to the top and profit from payments of others who might join later. For example, to join, you might have to pay anywhere from a small investment to thousands of dollars. In this example, $1,000 buys a position in one of the boxes on the bottom level. $500 of your money goes to the person in the box directly above you, and the other $500 goes to the person at the top of the pyramid, the promoter. If all the boxes on the chart fill up with participants, the promoter will collect $16,000, and you and the others on the bottom level will each be $1,000 poorer. When the promoter has been paid off, his box is removed and the second level becomes the top or payoff level. Only then do the two people on the second level begin to profit. To pay off these two, 32 empty boxes are added at the bottom, and the search for new participants continues. Each time a level rises to the top, a new level must be added to the bottom, each one twice as large as the one before. If enough new participants join, you and the other 15 players in your level may make it to the top. However, in order for you to collect your payoffs, 512 people would have to be recruited, half of them losing $1,000 each. Of course, the pyramid may collapse long before you reach the top. In order for everyone in a pyramid scheme to profit, there would have to be a never-ending supply of new participants. In reality, however, the supply of participants is limited, and each new level of participants has less chance of recruiting others and a greater chance of losing money. What You Should Know About Pyramid Schemes Things you should know about pyramid schemes 1. They are losers. Pyramiding is based on simple mathematics: many losers pay a few winners. 2. They are fraudulent. Participants in a pyramid scheme are, consciously or unconsciously, deceiving those they recruit. Few would pay to join if the diminishing odds were explained to them. 3. They are illegal. There is a real risk that a pyramid operation will be closed down by the officials and the participants subject to fines and possible arrest. 2 Why would anyone pay to join a pyramid scheme? Pyramid promoters are masters of group psychology. At recruiting meetings they create a frenzied, enthusiastic atmosphere where group pressure and promises of easy money play upon people's greed and fear of missing a good deal. Thoughtful consideration and questioning are discouraged. It is difficult to resist this kind of appeal unless you recognize that the scheme is rigged against you. Disguised pyramid - wolf in sheep's clothing Some pyramid promoters try to make their schemes look like multilevel marketing methods. Multilevel marketing is a lawful and legitimate business method which uses a network of independent distributors to sell consumer products. To look like a multilevel marketing company, a pyramid scheme takes on a line of products and claims to be in the business of selling them to consumers. However, little or no effort is made to actually market the products. Instead, money is made in typical pyramid fashion, from recruiting. New distributors are pushed to purchase large and costly amounts of inventory when they sign up. For example, you might have to purchase $1,000 of nearly worthless products in order to become a "distributor." The person who recruited you receives $500 (a fifty percent commission) and $500 goes to the top (the company, in this case). Notice the similarity to the simple pyramid scheme described earlier. Most disguised pyramids, however, are not this easy to unmask. Pyramid schemes often choose products which are cheap to produce but which have no established market value, such as new miracle products, exotic cures, etc. This makes it difficult to tell whether there is a real consumer market for the products. The best way to avoid a disguised pyramid fraud is to know what to look for in a legitimate income opportunity. How to Protect Yourself 1. Take your time. Don't let anyone rush you. A good opportunity to build a business in a multilevel structure will not disappear overnight. People who say "get in on the ground floor" are implying that people joining later will be left out in the cold. BEWARE! 2. Ask questions: • About the company and its officers. • About the products - their cost, fair market value, source of supply, and potential market in your area. • About the startup fee (including required purchases). • About the company's guaranteed buy-back of required purchases. • About the average earnings of active distributors. 3. Get written copies of all available company literature. 3 4. Consult with others who have had experience with the company and its products. Check to see if the products are actually being sold to consumers. 5. Investigate and verify all information. Do not assume that official looking documents are either accurate or complete. MULTI-LEVEL MARKETING OR ILLEGAL PYRAMID SCHEME? What is the Difference? "Multi-level" or "network" marketing is a form of business that uses independent representatives to sell products or services to family, friends, and acquaintances. A representative earns commissions from retail sales he or she makes, and also from retail sales made by other people that he or she recruits. Examples of well-known multi-level marketing companies include Amway and Mary Kay Cosmetics. Some companies call themselves multi-level marketing when they are really operating pyramid schemes that violate Michigan's Pyramid Promotion Act. Even when a multi-level plan does not violate Michigan's Pyramid Promotion Act, the marketing of the plan may violate Michigan's Consumer Protection Act, if the acts, methods, or practices are unfair, unconscionable, or deceptive. It is understandable that consumers often have difficulty telling the difference between an illegal pyramid scheme and a legitimate multi-level marketing opportunity. Governmental regulators and the industry continue to debate where the legal lines are drawn. Multi-level marketing is a lawful and legitimate business method that uses a network of independent representatives to sell consumer products. Commissions should only be paid on the sale of goods or services to non-participant end- user consumers. Pyramid schemes claim to be in the business of selling products to consumers in order to look like a multi-level marketing company. However, little or no effort is made to actually market the product. Instead, money is made in typical pyramid fashion...from recruiting other people to market the program. Sometimes, new "distributors" are persuaded to purchase inventory or overpriced products/services when they sign up. Pyramid companies make virtually all their profits from signing up new recruits and often attempt to disguise entry fees as the price charged for mandatory purchases of training, computer services, or product inventory. Pyramid schemes are not only illegal; they are a waste of money and time. Because pyramid schemes rely on recruitment of new members to bring in money, the schemes often collapse when the pool of potential recruits dries up (market saturation). When the plan collapses, most people, except the few at the top of the pyramid, lose their money. Market Saturation Although pyramid promoters claim that the possibility to earn is endless, this possibility cannot materialize due to market saturation. For example, if a program begins with one person who recruits two people, each one of whom recruits two more people, and so on, in only 28 levels practically the entire population of the United States - every man, woman, and child - would be involved, as is illustrated below. 4 Level Number of New Total Number of Participants Participants 1 1 1 2 2 3 3 4 7 4 8 15 5 16 31 6 32 63 7 64 127 8 128 255 9 256 511 10 512 1,023 11 1,024 2,047 12 2,048 4,095 13 4,096 8,191 14 8,192 16,383 15 16,384 32,767 16 32,768 65,535 17 65,536 131,071 18 131,072 262,143 19 262,144 524,287 20 524,288 1,048,575 21 1,048,576 2,097,151 22 2,097,152 4,194,303 23 4,194,304 8,388,607 24 8,388,608 16,777,215 25 16,777,216 33,554,431 26 33,554,432 67,108,863 27 67,108,864 134,217,727 5 28 134,217,728 268,435,455 When investigating a multi-level marketing opportunity, you should ask about market saturation and determine the saturation levels in your area of distribution.